Rules for renting to relatives

Renting to family members at a reduced rate with its advantageous tax regulations offers the opportunity to claim losses from renting and leasing. These usually result from depreciation and interest on loans associated with reduced rent. If you comply with certain rules when renting to children, you can deduct the expenses in full as advertising costs while only taxing the lower rental income. This tax-saving model also works when renting to dependent children.

As of 1 January 2021, there is an important change:

• If the agreed rent is at least 66% of the local market rent, the expenses can be fully deducted as advertising costs.
• If the agreed rent is between 50% and 66% of the market rent, the intention to generate income must be checked, and a profit forecast is required:
• If the profit forecast is positive, the advertising costs can be fully deducted.
• If the profit forecast is negative, the advertising costs must be apportioned and can only be partially deducted.
• If the agreed rent is less than 50% of the local market rent, the use must be divided into a paid and an unpaid part. The expenses can only be deducted as advertising costs in proportion to the paid part.

Important: If the rent is at least 50% but less than 66% of the local rent, a total surplus forecast check must be carried out:

If this total surplus forecast check is positive, the intention to generate income is assumed for the provision of discounted housing, and the full deduction of advertising costs is possible.

If the total surplus forecast check is negative, the intention to generate income is only assumed for the part rented for a fee. For the part rented for a fee, the advertising costs can be partially deducted.

The total surplus forecast check for income from renting and leasing is carried out according to long-standing and established BFH case law. The BMF letter of 8 October 2004 (BStBl 2004 I p. 933) remains applicable.

Note: When renting furnished or partially furnished apartments, it may be necessary to include a surcharge for the furnishings to determine the local market rent. Such a furnishing surcharge must be considered if it can be determined from a local rent index or marketable surcharges, according to the Federal Fiscal Court ruling of 6 February 2018 (IX R 14/17). It is not permissible to determine it in any other way. In particular, it is not permissible to derive a furnishing surcharge from the monthly amount of the linear depreciation for the furniture and furnishings provided. Nor is it permissible to apply a percentage rental yield surcharge.

The 50% or 66% threshold applies only to the rental of apartments, not to commercially or professionally used premises.

Currently, the Federal Fiscal Court has ruled that renting at a reduced rate to a dependent child can also be recognised for tax purposes if it meets the so-called arm's length comparison. This means that the rental agreement has been legally agreed, and both its design and the actual implementation correspond to what is customary between strangers. This requires that the main obligations of the contracting parties have been clearly and unambiguously agreed and implemented accordingly, even when renting to relatives. "Strict requirements are placed on the proof of the seriousness of contractual arrangements between closely related persons" (BFH ruling of 16 February 2016, IX R 28/15).

In the case in question, the rental agreement with the child was not recognised because the daughter did not actually pay any rent. Instead, the parents offset the rent against the daughter's maintenance claim and only paid her the difference in cash. This is the provision of maintenance in kind in the form of living space. There was no reduction in assets for the daughter as a tenant and no increase in assets for the parents as landlords. Since there is no paid use, the rental relationship is not recognised, and the expenses or loss were not recognised as advertising costs.

Instead of providing the child with the apartment as maintenance in kind and offsetting the rent against the child's maintenance claim, it is more tax-efficient to pay the child cash maintenance, from which they can then pay their rent for the apartment.

Currently, the Federal Fiscal Court has ruled that when renting furnished or partially furnished apartments, a furnishing surcharge must generally be applied, as such rentals are regularly associated with an increased utility value, which is often reflected in a higher local rent. However, such a furnishing surcharge should only be considered if it can be determined from a local rent index or marketable surcharges. It is not permissible to determine it in any other way (BFH ruling of 6 February 2018, IX R 14/17).

Note: The local rent can generally be taken from the local rent index. But what applies if there is a comparable apartment in the same building that is rented to strangers and whose rent differs from the local rent index? Should this comparison rent be used for the 50% or 66% threshold check, or should the rent index still be used?

In October 2019, the Thuringia Finance Court ruled that for comparison with the local market rent, the rent demanded by the landlord from a third-party tenant using a comparable apartment in the same building should be used (ruling of 22 October 2019, 3 K 316/19). An appeal was lodged against the ruling at the Federal Fiscal Court. And indeed, the landlord was successful.

According to the highest financial judges: The local market rent for checking the 66% threshold should generally be determined based on the rent index. If a rent index cannot be used or is not available, the local market rent can be determined by an expert opinion, information from a rent database, or based on the fees for at least three comparable apartments (BFH ruling of 22 February 2021, IX R 7/20).

Note: According to the Baden-Württemberg Finance Court (ruling of 22 January 2021, 5 K 1938/19), a total surplus forecast is exceptionally required despite compliance with the 66% threshold if it involves renting a lavishly designed residential building, in this case, a single-family house with well over 250 sqm of living space. However, whether this view can be upheld must now be decided by the Federal Fiscal Court. The appeal is pending under ref. IX R 17/21.

At first glance, the view from Baden-Württemberg may seem hardly tenable, as the tax regulation is actually clear and was also clear in the past. Section 21 (2) sentence 2 EStG states: "If the fee for permanent rental of a flat is at least 66% of the local rent, the rental is considered to be for a fee." However, there is indeed case law from the BFH in the past where it held a similar view to the FG Baden-Württemberg or at least signalled that a total surplus forecast might be appropriate in exceptional cases (e.g. BFH ruling of 30 September 1997, IX R 80/94 and BFH ruling of 6 October 2004, IX R 30/03). The BFH advocates a total surplus forecast if the market rent - usually the rent according to the local rent index - does not reflect the "correct" rental value or if, exceptionally, special circumstances speak against the intention to generate a surplus.

However, the relevant BFH rulings are somewhat dated, and the BFH has recently advocated the general use of the rent index if one is available (BFH ruling of 22 February 2021, IX R 7/20). It will be interesting to see how the BFH will decide now.

(2023): Rules for renting to relatives

Reduced-rate rental: Comparative calculation with apportionable service charges

Flats are often rented to relatives at a price below the local market rate. Such discounted rentals are advantageous for tax purposes because, on the one hand, only lower rental income needs to be taxed and, on the other hand, expenses can be fully deducted as income-related expenses.

There was an important change on 1 January 2021:

• If the agreed rent is at least 66% of the local market rent, the expenses can be fully deducted as income-related expenses.
• If the agreed rent is between 50% and 66% of the market rent, the intention to generate income must be checked, and a profit forecast is required:
• If the profit forecast is positive, the income-related expenses can be fully deducted.
• If the profit forecast is negative, the income-related expenses must be apportioned and can only be partially deducted.
• If the agreed rent is less than 50% of the local market rent, the use must be divided into a paid and an unpaid part. Expenses can only be deducted as income-related expenses in proportion to the paid part.

The Federal Fiscal Court has clarified that for the comparison calculation, "local rent" means the gross rent or warm rent. Consequently, the costs that may be passed on according to the Operating Costs Ordinance must be added to the comparable net rent (BFH ruling of 10 May 2016, IX R 44/15).

The "local market rent" includes the net rent plus the apportionable costs for flats of comparable type, location, and condition.

The costs apportionable according to the Operating Costs Ordinance include, in particular, property tax, water and sewage costs, heating, street cleaning and waste disposal, lighting, garden maintenance, chimney cleaning, property and liability insurance, and caretaker costs (§ 2 BetrKV). Maintenance and repair costs are not included according to § 1 BetrKV. Therefore, the warm rent paid is compared with the local warm rent (see also R 21.3 EStR).

The calculation method with warm rents is more advantageous for landlords than the calculation with net rents, as it includes operating costs. These costs represent a significant part that the tenant usually fully bears even in the case of discounted rental.

The Federal Fiscal Court recently ruled that when renting furnished or partially furnished flats, a furniture surcharge is generally to be taken into account. Such rentals often come with increased utility, which is often reflected in higher local rents. However, such a furniture surcharge is only acceptable if it can be derived from a local rent index or realisable market surcharges. Other methods of determination are not permitted (BFH ruling of 6 February 2018, IX R 14/17).

Regarding the examination of the 50 or 66 percent threshold for the local rent, there is the question of whether to refer to the local rent index or the rent of a comparable, externally rented flat in the same building. The Thuringian Finance Court decided in October 2019 that the rent of a comparable externally rented flat in the same building should be used (judgment of 22 October 2019, 3 K 316/19). However, this judgment was appealed before the Federal Fiscal Court, and the landlord was successful.

The highest financial judges clarified that the local market rent for checking the 66 percent threshold should generally be determined based on the rent index. If no rent index is available or does not exist, the local market rent can be determined by expert opinions, information from a rent database, or by the comparative rents of at least three similar flats (BFH ruling of 22 February 2021, IX R 7/20).

(2023): Reduced-rate rental: Comparative calculation with apportionable service charges

What should you be aware of with short-term rentals (e.g. Airbnb)?

If you rent out your flat or house on a short-term basis, for example to earn extra money through platforms like Airbnb, you must pay tax on the rental income. This applies even if you only sublet occasionally or for a short period.

However, there are ways to reduce your tax burden. You can present all advertising costs related to the rental to the tax office. You can deduct these from the rental income you have earned, thus reducing your taxes.

Deductible advertising costs include, among others:

• Proportional rent or interest for the rental period: If you rent out a room in your flat, you can claim part of your rental costs as advertising costs.
• Proportional renovation and maintenance costs: If you carried out renovation work or repairs before renting, you can claim these as advertising costs. Ongoing maintenance costs, such as servicing the heating system, can also be deducted.
• Proportional utility costs for the rented space, such as heating, water, gas: If you rent out a room in your flat, you can deduct part of the utility costs as advertising costs. You should allocate the total costs of your utility bill accordingly.
• Payments to Airbnb: You can also deduct the costs you pay for using the Airbnb platform as advertising costs.
• It is important to collect all receipts and invoices related to the rental. This is the only way to prove which costs you actually incurred and claim them as advertising costs.

To ensure that you comply with all tax aspects of short-term rentals, you should consult a tax advisor. This way, you can ensure that you do not overlook any important points and avoid unexpected tax back payments.

(2023): What should you be aware of with short-term rentals (e.g. Airbnb)?

What is the energy performance certificate and what costs are involved?

The energy performance certificate is a document that assesses the energy requirements of a building. There are 2 types of energy performance certificates: the requirement-based certificate and the consumption-based certificate. The requirement-based certificate considers the building's energy needs, while the consumption-based certificate analyses the actual energy consumption of recent years. Energy performance certificates are valid for ten years from the date of issue.

As a landlord of a residential building in Germany, you are legally obliged to provide an energy performance certificate for your property. The certificate provides information about the building's energy requirements and serves as a guide for tenants and buyers. However, there are costs associated with obtaining the energy performance certificate, which can affect landlords.

The costs for obtaining an energy performance certificate depend on various factors, such as the size of the building, the type of certificate, and the effort required by the energy consultant. Generally, the expenses range from 150 to 600 Euro.

Claiming the energy performance certificate as income-related expenses for landlords

As a landlord, you can claim the costs for obtaining an energy performance certificate as income-related expenses in your tax return. This applies regardless of whether you obtain the certificate due to a legal obligation or voluntarily. The costs can be claimed as income-related expenses under rental income.

The costs for the energy performance certificate are immediately deductible income-related expenses. It is advisable to keep the invoice for the energy performance certificate in case it is requested by the tax office.

(2023): What is the energy performance certificate and what costs are involved?

What costs can landlords deduct for tax purposes during a vacancy?

Anyone renting out property in Germany must not only manage the rental, tenant selection, and support but also be prepared for vacancies. If a flat or house is vacant for a certain period, it can lead to financial losses. But what options are there to deduct expenses for temporary vacancies for tax purposes?

What are expenses for temporary vacancies?

Expenses for temporary vacancies include all costs incurred in connection with renting out property but cannot be covered by rental income due to vacancies. These include costs for maintenance and repairs, advertising, energy costs, property tax, and waste disposal fees. However, the vacancy must actually be temporary, meaning there must be a realistic chance that the flat or house will be rented out again.

Tax deductibility of expenses for temporary vacancies

Expenses for temporary vacancies can be deducted for tax purposes, but certain conditions must be met. Firstly, the costs may only arise if the property is rented out and no income is generated. Secondly, the costs must be necessary and reasonable, i.e., no luxury renovations or unnecessary maintenance work should be carried out.

The deductible expenses are claimed as income-related expenses under income from renting and leasing. They must be stated in the tax return for the relevant year. When calculating income tax, they are then deducted from rental income.

Overall, expenses for temporary vacancies can be deducted for tax purposes if they are necessary, reasonable, and actually incurred. However, landlords should ensure that the vacancy is indeed temporary and that there are realistic prospects for renting. If landlords have any uncertainties or questions about tax deductibility, they should consult a tax advisor.

(2023): What costs can landlords deduct for tax purposes during a vacancy?

What applies to rental income from abroad?

As a rule, the foreign country where the property is located has the right to tax the income from renting and leasing (taxation in the document unit state). The foreign rental income is then tax-free in Germany but subject to the progression clause.

However, if the rental property is in an EU/EEA country, the rental income is not subject to the progression clause. Rental income from the EU/EEA does not need to be declared in the income tax return.

However, losses from renting out a foreign property in the EU/EEA cannot be claimed in the German tax return, even if they are not taken into account for tax purposes abroad (FG Baden-Württemberg of 8.7.2014, 4 K 1134/12).

Please note: An important exception applies to properties in Spain. Rental income must be declared in Germany in the "V" form. The income tax paid in Spain on the rental income can be credited against German income tax.

Rental income from third countries (non-EU/EEA countries) is fully subject to the progression clause in Germany and must be declared in the AUS form. The foreign income must then be determined according to German tax regulations. Note: The AUS form is currently not available in Lohnsteuer kompakt.

Be careful: Some double taxation agreements (e.g. with Switzerland) provide for the so-called credit method. In this case, the foreign rental income must be declared in the "V" form. The income tax paid abroad on the rental income can be credited against German income tax.

Therefore, each individual case of foreign property must be carefully examined to determine which country has the right to tax, whether the exemption or credit method applies, and whether the progression clause applies.

(2023): What applies to rental income from abroad?